PROBLEMS 1:
Nonconstant Growth: A company will pay a $2 per share dividend in 1 year. The dividend in 2 years will be $4 per share, and it is expected that dividends will grow at 5 percent per year thereafter. The expected rate of return on the stock is 12 percent.
A. What is the current price of the stock?
B. What is the expected price of the stock in a year?
C. Show that the expected return, 12 percent, equals dividend yield plus capital appreciation
PROBLEM 2:
Earnings and Leverage: Reliable Gearing currently is all-equity financed. It has 10,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital-restructuring. The low-debt plan calls for a debt issue of $200,000 with the proceeds used to buy back stock. The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 10 percent. The firm pays no taxes.
A. What will be the debt-to-equity ratio after each possible restructuring?
B. If earnings before interest and tax (EBIT ) will be either $90,000 or $130,000, what will be earnings per share for each financing mix for both possible values of EBIT? If both scenarios are equally likely, what is expected(i.e., average) EPS under each financing mix? Is the high-debt mix preferable?
C. Suppose that EBIT is $100,000. What is EPS under each financing mix? Why are they the same in this particular case?
Problem 3:
Dividend Policy. For each of the following four groups of companies, state whether you would expect them to distribute a relatively high or low proportion of current earnings and whether you would expect them to have a relatively high or low price-earnings ratio.
A. High-risk companies.
B. Companies that have recently experienced a temporary decline in profits.
C. Companies that expect to experience a decline in profits.
D."Growth" companies with valuable future investment opportunities.